The Financial Health of the Maryland State Pension System

As counties take over a share of the costs of the Maryland Teachers’ Pension, they have a greater interest in the state pension system’s overall financial health.  In this post, we review the vital signs of the whole system, compare it to other public pensions and explore the effects of legislative reform and market trends.  Our review finds that recent reforms of the system set it on-course for improved funding levels, despite varied investment returns.

Public Pension Pandemic

In recent years, pension plans across the country have been struggling.  Public pension plans are underfunded and the ability of investment returns alone to close those gaps proves difficult in a lagging economy.  As reported in Governing,

The Pew Center on the States estimates that all funds combined currently operate at a $1 trillion deficit [45% of which is pension cost; 55% health care], leaving many state public pensions funded well below the 80 percent level suggested by the U.S. Government Accountability Office (GAO).

The Maryland pension system is underfunded, too, reporting a funding level of 67% in June 2011.  However, the Board of Trustees expects the system to reach a healthy level of 80% funding by 2023 as a result of pension reforms enacted by the General Assembly in 2011.

Legislative Doctoring

Over the years, the General Assembly’s attempts to reform the pension system helped improve its funding, while the benefit enhancements and funding exceptions they enacted created further set-backs.   According to the Department of Legislative Services, the General Assembly began working in 1979 and 1984 to avoid a future of ever increasing pension costs.  The 1984 reforms had a positive effect, and the financial and actuarial condition of the system steadily improved throughout the twenty years following their enactment.  As described by the Department of Legislative Services,

The State’s overall contribution rate for the system decreased from 17.6% of payroll in fiscal 1985 to 7.97% in fiscal 2005. The market value of the system’s assets increased from $2.3 billion in fiscal 1980 to over $32.1 billion at the end of fiscal 2005. Moreover, for the first time in the history of the system, at the end of fiscal 2000 (approximately 20 years ahead of statutory schedule), the system was fully funded on an actuarial basis with an overall funding ratio of assets to liabilities of 101%.

In 2002, the General Assembly enacted the Bridge to Excellence (“Thornton”) legislation, providing additional funding for education.  Some of this funding translated into jobs and salary increases for educators, which created additional liabilities for the pension system.  In the seven years following Thornton, general fund expenditures for teacher pensions grew by 93%, and teacher pension costs grew by 159%.

Also in 2002, the General Assembly also changed the rules regarding funding for the pension system by enacting the “corridor” funding method.  As described by the Department of Legislative Services,

Faced with the prospect of dramatic increases in State contribution rates in fiscal 2002 due to investment losses, the State adopted a proposal to reduce the volatility of its contribution rates while still maintaining advance funding of its pension liabilities. Under the new approach, which was incorporated into the Budget Reconciliation and Financing Act of 2002 (Chapter 440), the rates for the largest systems – the employees’ and teachers’ systems – remained fixed at the fiscal 2002 certified rate as long as their funding levels remained in a “corridor” of actuarial funding from 90 to 110%.

In 2006, the General Assembly increased benefits and increased the multiplier used to calculate pensions from 1.4 to 1.8 for the Teachers’ and Employees’ pension systems.  The benefit enhancement was made retroactive to 1998, so it affected a large number of employees, increasing liabilities by $1.9billion.  Since pension benefits are calculated by multiplying (years of service) x (average final compensation) x (this multiplier), the more generous multiplier significantly increased the system’s costs.

Following these changes, the contribution rate doubled, rising to 13.40% in fiscal 2012.  The General Assembly acted to counter this trend in 2011, passing significant system reforms.  These reforms raised employee contributions to 7%, delayed pension vesting from five to ten years, and required the last five highest years of salary, rather than the last three, to be used in calculating retirement benefits.

Market Maladies

Poor investment returns in periods of economic downturn have contributed to the underfunded status of the pension system.  According to the State Retirement Agency, the increase in contribution rates in recent years was affected by the “dot com” bubble burst of 2001-2002 and the financial market collapse of 2008-2009.  The “dot com” bubble burst effected a -7.6% return for the Maryland State Retirement and Pension System in 2002.  The market failures of 2008 created an additional increase in actuarial liabilities.  As the Department of Legislative Services describes,

The most dramatic decrease was from the end of fiscal 2008 to the end of fiscal 2009, when the funding status decreased from 78.62 to 65.02%, a change of almost 14.0%. This decline is largely attributable to the effects of the turmoil in the financial markets that began in fall 2008 and carried through spring 2009.

Pension Pulse

In more recent years, pension investment returns have been variable.  The State Retirement Agency recently reported a 0.36% investment performance in 2012, down from 20.04% in 2011.  The Board of Trustees is contemplating further statutory reforms in 2013 to address both funding and administrative issues with the systems.  Proposals presented to the Joint Committee on Pensions last week include a range of oversight and financial matters, and the committee is expected to continue analyzing related policies through the remaining interim.

(editing note – a previous version of this article made reference made reference to administrative proposals initiatited by the Agency, as part of a forthcoming legislative package, and inadvertently suggested that these matters were meaningfully attributable to the system’s unfunded liability – a corrected version of the article is above)

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